Global perspectives on risk from some good minds

Ri$kMinds 2011, Geneva, Switzerland

Meeting of the Minds on Risk at a global gathering of thought leaders, regulators, academics, executives, consultants and practioneers!

There were many different perspectives and ideas shared at the recent Ri$kMinds event. There were numerous notable quotes from regulatory and banking executives, such as:

  •  Concerning financial innovation: "We need a more formal process to distinguish healthy innovation versus arbitrage" -- Jose Maria Roldan, Banco De Espana
  • Concerning safety & soundness: "We need to raise the resiliency of all banks" -- William Coen, Basel Committee on Banking Supervision
  • Concerning how much capital is enough: "There needs to be agreement on the question of "how much" if banks are to properly make their contribution and meet their accountabilities and obligations to the societies and economies in which they operate." -- Alan Smith, HSBC

On the last point, it is my opinion that we will see greater agreement between regulatory authorities and financial institutions on how much capital is required.  We'll get there through a deeper understanding,  and more accurate quantification, of lending risk, made possible by sourcing of additional data, simultaneous holistic classification and aggregation of risk estimates, and improvements in risk modeling.  This has direct implications for improved ABS pooling methodology, risk disclosure and rating, which is the subject of some recently published work spearheaded by Mingyuan (Sunny) Zhang. 

Greater Regulation, But Choices Remain

There certainly is no disputing that the financial services industry today is subject to far greater regulation and oversight at an institutional level, country level, and systemically.  That said, I am detecting a growing shift from pure compliance to more competitive uses of risk information and analysis. 

New capital requirements may constrain overall risk exposures, but companies can choose the mix of necessary and sufficient financial assets and funding sources to ensure they achieve their overall return targets.

This includes not only taking and maintaining capital markets positions for traded financial instruments, but also evaluating and adopting strategy relative to which business to grow, or downsize.  Those decisions are critical to achieving the right portfolio mix of customer-based assets, which makes up the largest share of interest and fee income for banks.  This sort of decision-making is, of necessity, information-intensive and analysis-based. Definitely not "back of the napkin" exercises! Further, the concepts of stakeholder risk appetite (the amount of risk an organization is willing to accept in pursuit of its business objectives) and risk tolerance (acceptable degree of variance from the appetite) are central to any risk-based decision process. To anticipate what might happen relative to liquidity, counterparty exposure, asset values and a host of other concerns (including the worst that could happen), decision-makers can utilize stress-testing, reverse stress testing, and stressed VaR, coupled with advanced economic and time series forecasting, Monte Carlo simulation, and optimization. There were many successful applications of these, and other analytical techniques, shared at the conference.

Increasing Role of Enabling Technology

What continues to emerge post-financial crisis is movement towards a more holistic and integrated risk management program at financial institutions.  This is being driven by desires to streamline operations, reduce costs, speed delivery, avoid surprises, and better price risk.  In addition, competition is getting fiercer, funding spreads are about as narrow as they get, public trust of banks has been slow to recover, regulatory scrutiny has ramped up significantly, the recession has dragged on, and so on.  Banks, and other financial institutions, realize that this is no time to sit back and just try to weather the storm.   The choices they make today will sow the seeds for either their success, or failure, tomorrow.  President Obama has put forth a Strategy for American Innovation, in which he makes the case to the American people that innovation is a primary pathway to better times.  Technological innovation represents an important area that corporate executives can turn to for help.

Financial institutions want to be more pro-active, and recent breakthrough technology can boost their ability to do so.

More specifically, operating results, balance sheet planning and business strategy need to be combined in meaningful ways in order to surface important concentrations, co-dependencies, gains, gaps and trends.  The supporting processes for this holistic performance and strategy analysis must enable increasingly swifter and more reliable delivery.  In the world of high-finance, timing can be everything, and advance notice goes a long way towards ensuring successful strategy execution.  High performance computing, in addition to management of big data, can really help firms on both fronts, by anticipating market adversity and also by identifying opportunity.  Both are key ingredients to a top-tier Risk Management Program.

I will have much more to say about each of them in future blogs, in addition to some predictions for regulatory reporting and a brighter future! Please stay tuned!

tags: risk

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